If you want to sell your home because you’re no longer capable of paying for it, you may want to consider a short sale. This sale allows you to sell your property for less than you owe to the lender. While short sales aren’t common, they comprise around 5% of single-family home transactions.
Homeowners typically consider short sales when they are in financial distress or need to offload a home with an underwater mortgage. If an owner finds it nearly impossible to make their monthly mortgage payments, they can opt for a short sale.
While this type of transaction comes with many risks, there are also numerous potential benefits for buyers and sellers alike. For example, homeowners will be able to get rid of a debt that they likely can’t afford to pay. Buyers can use this strategy to purchase real estate at a discount. This guide answers the question “What is a short sale in real estate?”
How a Short Sale Works
A short sale is a process in real estate that occurs when a potential buyer makes an offer to buy a home at an asking price that’s below the amount that’s owed on the mortgage. This type of transaction usually takes place because of the homeowner’s financial hardship. For example, homeowners often engage in short sales when they need to avoid the foreclosure process.
When a short sale takes place, the owner’s lender receives all the proceeds. The lender can take two approaches when approving a short sale. They can either forgive the entirety of the remaining balance or seek a deficiency judgment. When a judgment is made against the former homeowner, they will be required to pay a portion or all of the difference.
If you decide to take part in the short-sale process, you’ll need to list your home. When doing so, make sure you mention that the transaction is a short sale/subject to lender. When taking part in this sale, you’ll need to provide your lender with some documentation. For example, you must submit a hardship letter that informs your lender why you’re unable to continue making your mortgage payments.
You may also be asked to submit financial documents that back up your financial hardship, such as medical bills and income statements. Once you submit this documentation, the lender will likely appraise your home to identify if the offer letter is fair based on your financial situation and the condition of your property. If your lender approves the short sale, they might include some stipulations you’ll need to adhere to.
Short Sale vs. Foreclosure: What’s the Difference?
Foreclosures and short sales take place when homeowners are unable to make their mortgage payments on time. This type of transaction may also be pursued if the owner’s mortgage is underwater, which means that the home is worth less than the borrower owes. No matter which process occurs, the current homeowner will lose possession of their property. However, the consequences differ.
A short sale is a voluntary process that begins when the homeowner submits a financial package and requests approval from a lender to offload their property at an amount that’s less than they owe on it. Lender approval is required.
Once the owner receives lender approval, they can attempt to sell their property. Keep in mind, however, that the lender will be responsible for handling negotiations. They’ll also determine if a buyer’s offer should be accepted or rejected. Even though the lender has approved the sale, their goal is to avoid a loss, which means that offers can be rejected.
The foreclosure process is different than a short sale and more troublesome for the homeowner. It’s a legal action that lenders can take when the homeowner ceases their mortgage payments. While both options can hurt your credit score and history, foreclosures are considerably more damaging. Foreclosures can also be expensive for both parties, which is why a short sale is often the preferred option.
How Buyers Benefit from Short Sales
Short sales can be highly advantageous for lenders, sellers, and buyers. If you’re buying a home via a short sale transaction, you might not pay as much money. While a short-sale property might initially be priced close to the market value, the lender will want to sell the home quickly, which means that a significantly lower offer might be accepted.
You’ll also benefit from less competition than in regular sales. Short sales are more complex than traditional ones because of the lender’s involvement. Because of this complexity, many potential buyers seek other options.
Buying a short-sale home also comes with fewer risks than purchasing a foreclosed home. If you obtain a home inspection, you can identify issues that need to be remedied once the transaction closes. However, banks don’t need to disclose this information when selling foreclosed properties.
The Short Sale Process for Buyers
When going through the short-sale process as a buyer, you must obtain pre-approval for financing. Lenders want to be certain that buyers have the financial means to purchase a short-sale property. If you want a lender to consider your offer, you must be pre-approved.
It’s also a good idea to partner with a real estate agent if you’d like to secure a short sale. An experienced agent can assist you with searching through public records and looking for preforeclosure listings online.
Make sure you do your research before making an offer on this type of property. It’s important that you identify the home’s current market value. You should also find out how much the homeowner currently owes the lender. Before making an offer, verify that there aren’t any other people or entities with claims to the property. Your offer should be close to the current market value, which makes it more likely that the lender will be satisfied and recoup most of what they’re owed.
Before you buy the home, have it inspected. These properties are typically sold “as-is”, which means that they might not be in the best condition. Even though the owner must disclose any defects they know of, some issues can be missed without an inspection.
Once the lender accepts your offer, you can expect the loan underwriting process and due diligence to take around 90-120 days to be completed. You’ll be tasked with submitting financial documents as well as the approval letter. This process takes longer than a traditional home sale because lenders usually make some demands in an attempt to recover as much money as possible. For example, they might ask you to cover all repairs.
How Sellers Benefit from Short Sales
Sellers can also benefit from short sales. For example, this type of transaction allows you to avoid the foreclosure process. Keep in mind that a foreclosure can be more damaging to your credit score. With a short sale, the lender will be tasked with covering closing costs and agent commissions.
Selling your home through a short sale also guarantees that you’ll be able to pay off most of your debt to the lender. As mentioned previously, some lenders write off all remaining debt after they recover the proceeds from the short sale.
It’s also easier to reenter the housing market after engaging in a short sale. You might be able to qualify for a Federal Housing Administration (FHA) loan without needing to wait for several years.
The Short Sale Process for Sellers
You’ll be responsible for listing your property as a short sale, which means that buyers need to know the type of transaction they’re about to take part in. When you list your property, make sure you affix a description that says “short sale” or “subject to bank approval”.
As mentioned before, you must gain approval from the lender when negotiating this type of sale. The lender will decide which offer is accepted, which means that they’ll communicate with the buyer’s agent to negotiate all the pertinent details. To gain lender approval, you’ll need to submit a hardship letter as well as financial documents that prove your hardship.
The hardship letter you submit to the lender should be as convincing as possible. You’ll need to protect your interests and explain why you can’t afford the mortgage payments.
When submitting your financial documents, be careful about what you claim. If your lender doesn’t approve the sale, they could use the financial information you provide to obtain money from you when they foreclose on the property. For example, they might seek any cash assets you claim to have. Keep in mind that lenders can take anywhere from three to 12 weeks to approve a short sale.
Risks and Drawbacks of Short Sales
There are a few risks and drawbacks associated with short sales that you should consider.
For Buyers:
When you’re buying a short-sale property, you must be prepared for this process to take anywhere from 90-120 days. Along with a lengthier process, you’ll also deal with increased paperwork. Because of the complexity of this transaction, you may need to hire a real estate lawyer to help you navigate it. These properties are sold in “as-is” condition, which means that might not be in great condition.
For Sellers:
While this type of sale allows you to avoid foreclosure, there are some downsides. For example, the lender has all the negotiating power on the sale price. It’s also impossible for you to make a profit on the home.
While a lender can choose to discharge all remaining debts associated with the property after it sells, they can also seek a deficiency judgment, which involves suing the seller to retrieve the funds.
This type of judgment can be damaging to your credit as well as your financial situation. After you complete a short sale, you must wait for around two to seven years before you apply for another mortgage. FHA loans don’t come with a waiting period.
Tips for Buying a Short-Sale Home
If you’re interested in buying a short-sale home, it’s highly recommended that you obtain an inspection as well as repair estimates. These estimates can help you negotiate a lower price with the lender.
It’s also important that you make a reasonable offer to the lender. Even though they want to sell quickly, they won’t accept low-ball offers or ones with numerous contingencies. Lenders are more likely to accept offers if large down payments are made. You can also make an all-cash offer to increase your chances.
Consider negotiating some of the extra costs associated with a short sale to ensure your offer appeals to the lender. For example, you could offer to pay the closing costs.
Conclusion
Short sales are a viable option for buyers and sellers alike. They allow buyers to purchase homes at a discount, while sellers can get out of a mortgage they can’t afford. Weigh the pros and cons of a short sale based on your personal circumstances. To properly navigate this process, it’s a good idea to work with a reputable real estate agent.